As with any real estate mortgage, almost every type of commercial real estate loan requires a down payment against your borrowing. The average amount is 25 to 30% for commercial real estate, but different loan products, different lenders, and your relationship with individual lenders will all influence how much money down is necessary for your loan.
This leaves you to weigh the pros and cons of leverage and determine the down payment that will best serve your real estate investment strategy or business.
Determining the Right Leverage for Your Real Estate Purchase
The down payment necessary for a commercial real estate loan will first depend on what banks or non-bank lenders are willing to offer you. Most banks will have an internal policy as to what percentage of a purchase they will finance that is highly dependent on current market trends, property types, and past relationships with individual customers. For real estate investing in properties that are selling above value, many bank lenders will require a higher down payment to offset potential cash flow issues.
Some commercial loan products will have different rates as well. For instance, commercial real estate loans from the Small Business Administration like the SBA 504 and SBA 7a provide loans with a 10% and 0% down payment respectively.
Once you know what use can secure, you will need to determine how much it makes sense to leverage in terms of your business or investment goals, and consider both short term and long term goals. The pros of putting less cash down and leveraging more include:
- Greater Liquidity – By retaining more cash, you can make other investments in the near term. This is helpful if you are growing your business on multiple fronts or you want to stay flexible and in fast commercial real estate.
- Protection Against Property Value Change – This is less of a concern as the real estate market continues to go up, but if you had a significant amount of money invested and property values dropped, the larger down payment would be caught up in decreased property values.
- Reduced Equity – Depending on your specific circumstances, you may have more accessible equity by retaining cash assets instead of converting that cash fully into real estate.
Many of the benefits of a smaller down payment and keeping more cash on hand are most valuable in the short term when companies are looking to capitalize on growth or more frequent real estate moves in the next few years.
Meanwhile, some of the drawbacks to putting down a smaller down payment can have a greater impact in the long term. These drawbacks include:
- Lower Interest Rates – Putting down a higher down payment makes you a less risky borrower and secures a lower interest rate. Additionally, loans with higher leverage often require investors to borrow from non-bank lenders, which generally comes with an interest rate that is a few points above the market average. The lower interest rates result in cost savings over time.
- More Flexible Monthly Cash Flow – Although you will need more cash up front, a lower interest rate will mean lower monthly payments, giving you greater flexibility in cash flow from month to month throughout the life of the loan.
- Protection Against Property Value Loss – There can be some benefits to having extra cash in the event of changing property values, having less equity will be more beneficial in the event of a recession.
- Easier Refinancing – At the end of your commercial loan term, a smaller initial down payment will leave you with more principle when it comes time to refinance, meaning it might be necessary to put forward more collateral at that time or accept a higher interest rate.
There is no one right answer for how much leverage is the right amount in commercial real estate. In many cases, putting as much down as you can is beneficial, but specific business plans or investment strategies mean it is necessary that you have more cash ready to go should you need it.
Being conscious of your short term and long terms goals will be a necessity in selecting the right loan product, down payment, and interest rate for your needs, but an experienced commercial lending
experts can also help you through the process by providing answers to your various questions, input from similar customer experiences, and other guidance.
At Landrum Loans, we help our clients secure commercial real estate loans for a range of different property investments and are dedicated to helping you get the terms that are right for your business. Contact us today to learn more about what we can offer at Landrum Loans and get started with the application process.